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Friday, January 28, 2011

Nenner Nails It

Charles Nenner

During a radio interview three weeks ago, cycle analyst Charles Nenner predicted that the rally in Bank of America's stock would end shortly, either when the share price hit $14.70 or around January 14. Turns out he was right on. Look at the chart below:

That white candlestick you see at the top of the formation came on January 14, when BAC ended the trading day above 15. Since then it has been all downhill. As I write, the stock sits a buck below Nenner's target price.

If MainePERS portfolio managers had acted on Nenner's exit call, they could have saved themselves, and us, $2.5 million. I say "us" because, as guarantors of retirement pay-outs to the state's public employees, we taxpayers effectively own everything in the MainePERS portfolio. Any losses in that portfolio will have to be restored out of the General Fund to preserve future benefits.

My contention is that equity managers at MainePERS need to be more selective in their stock-picking and quicker to cut losses. BAC has underperformed for a long time and shows no signs of turning things around. Just a week ago the company reported a fourth-quarter loss of $1.2 billion, despite a release of over $1 billion in loan-loss reserves and the multi-billion-dollar sale of most of its one-third stake in BlackRock, the giant asset manager. For all of 2010, Bank of America lost $2.23 billion. Why hold such a dog?

It figures to get worse. The company's chief financial officer warned during a conference call with analysts of another $7 to $10 billion in losses to come for home loans and mortgage-backed securities sold to private investors, who want to put the toxic assets back onto Bank of America. Their beef? That BofA did not properly disclose the riskiness of said assets. The company has already settled with the GSEs on some of the slime, but there's more out there. A lot more. Maybe a quarter of a trillion dollars worth in defaulted and seriously delinquent loans.

BofA's ballpark estimate of $7-10 billion in future putbacks appears optimistic. A suit filed in the last week by several insurance companies alleges "massive mortgage fraud" by Countrywide Financial, which is now part of Bank of America. Preliminary research of a sample of 19,000 Countrywide loans found that over 90% of defaulted or delinquent loans "contained material deviations from Countrywide's underwriting guidelines." If that defect rate can be successfully extrapolated, then BofA needs to up its exposure estimate by a factor of 20.

Company officers admitted on the conference call that it may take years to sort through the mess. Which means that BAC is, at best, dead money until these issues are resolved. At worst, shareholders will get wiped out, which would set MainePERS back a penny or two. Nenner sees the stock sinking back at least to the November lows. The time to dump it, as he had predicted, was two weeks ago.

A useful hint to do just that came the day before the January 14 high, when Robert Lenzner, writing for Forbes, brought attention to an accounting convention that has allowed lenders to overstate revenues. As mortgages mature, lenders are allowed to recognize interest income whether or not borrowers actually make their payments. The phantom income representing accrued, but unpaid, interest does not come off the books until thebanks actually foreclose on the distressed properties, a process that can take 16 months or--when the paper trail is sketchy--longer. Right now phantom income is accruing on $1.4 trillion in face-value mortgages industry-wide. So add looming write-offs to the list of reasons to question the earnings power of the big banks.